The Russell 2000 has fallen over 15% since its late-2024 peak as small-cap CEOs grow cautious and investors hedge with options, driving sentiment on their earnings calls to all-time lows versus large-cap peers. 

Higher rates, floating-rate debt, thin margins, and an expanding tariff regime have squeezed these firms more than big companies. 

Yet a push for reshoring and targeted federal spending under a potential Trump administration could give nimble, domestically-focused small caps an edge. 

Despite this, the market is pricing in almost no profitability improvement, so careful stock selection will be key to catching any small-cap rebound.

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The Russell 2000 slid more than 15% since peaking in late 2024. Institutional sentiment has soured, and the corporate tone is deteriorating fast.

According to Bank of America, sentiment scores from small-cap earnings calls are at their lowest levels ever recorded relative to large-cap peers.

Compared to the steadier tone of large-cap leaders, small-cap CEOs are increasingly signaling stress and, in some cases, pulling back on growth plans entirely.

More investors are buying insurance to protect against a drop in small-cap stocks, especially through options against the iShares Russell 2000 ETF (IWM).

Activity in this kind of protection recently spiked, just like it did before the last downturn.

Pessimism tends to cluster at turning points. Things look uncertain for the economy right now, and small companies have less wiggle room.

They’re more exposed to short-term pressures than their large-cap peers, especially in a “higher for longer” rate environment.

That’s because these companies tend to carry more floating-rate debt, run with thinner margins, and lack the global diversification that cushions volatility.

And trade policy isn’t helping.

Sectors like auto parts, transport, capital goods, and component manufacturing, which together make up about 15% of the Russell 2000, are in the crosshairs of an expanding tariff regime.

That exposure is up from just 9% of the S&P 500 index’s representation, according to Bloomberg Intelligence.

Still, it’s not all bad news. Some small caps may benefit from exactly the same trends that are causing pain today.

If tariffs increase further under a potential Trump administration, a scenario markets are already gaming out, domestic producers could gain share.

That could be a turning point for reshoring-sensitive sectors like shipbuilding, infrastructure, defense components, industrial tech, and even specialty materials.

These are areas where smaller firms have a natural advantage. They’re faster to adapt, closer to end customers, and deeply tied to local supply chains.

More importantly, they’re also set to receive a bigger share of federal spending.

The Trump administration’s push for industrial revival and supply chain independence favors companies that are nimble, domestic, and strategically aligned with national interests.

These smaller firms, often overlooked during globalization, now stand to gain from targeted federal support, ranging from tax cuts and subsidies to defense procurement and infrastructure spending.

Many of them happen to sit inside the Russell 2000.

However, none of this optimism towards small caps is priced in…

We can see this through our aggregate Embedded Expectations Analysis (“EEA”) framework.

We start with the average stock price of all companies in the Russell 2000 index.

From there, we can calculate what the market expects from future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well the Russell 2000 has to perform in the future to be worth what the market is paying for today.

Uniform return on assets (“ROA”) of the companies in the Russell 2000 index has been between 6% and 8% over the last five years.

And analysts expect Uniform ROA to slightly improve to 8% by 2026. However, the market expects the profitability of Russell 2000 companies to stay around 7% by 2029.

Take a look…